Gelpern: Domestic Bonds, Credit Derivatives, and the Next Transformation of Sovereign Debt

Anna Gelpern (Rutgers Univ., Newark - Law) has posted Domestic Bonds, Credit Derivatives, and the Next Transformation of Sovereign Debt (Chicago-Kent Law Review, forthcoming). Here's the abstract:

The emerging market financial markets are experiencing a fundamental shift. Between 1995 and 2005, domestic debt in poor and middle-income countries grew from $1 trillion to $4 trillion, with most of the growth in public sector borrowing. In Mexico, domestic government debt went from just over 20% of the total debt stock in 1995 to nearly 80% in 2007. Over roughly the same period, credit default swap contracts referencing emerging market entities (most of them sovereign) grew from zero to $300 billion in notional amount outstanding, surpassing market capitalization of the leading emerging market debt index and projected to double annually. The growth of domestic bonds and credit derivatives makes the emerging markets look more "mature", or mainstream. But a closer look at recent changes suggests that the rhetoric of mainstreaming and convergence may obscure more than it reveals. Emerging and mainstream markets use formally identical instruments, yet this formal resemblance need not stand for substantive identity. Nor does the overlap between emerging and mainstream market participants reflect the rise of a single market. Instead, investors use the same instruments differently in different markets, which, as the examples in the text suggest, can be its own source of risk.

This paper focuses on the implications of recent changes for studying emerging market sovereign debt. For more than a decade, writing about this debt meant writing about the shift from bank loans in the 1970s to bonds in the 1990s, and the attendant collective action problems. The contracts at the center of this literature were denominated in foreign currency, governed by New York or English law; the creditors were foreign residents. Law scholarship has yet to engage with the shift from foreign-law, foreign-currency to local-law, local-currency bonds, where the creditors are diverse and churn constantly. The goal of this paper is to map the ongoing transformation in a way that highlights gaps between formal and substantive convergence of emerging and mainstream markets, and suggests directions for future research.